Individuals purchase insurance products for a variety of reasons, whether it is simply to ensure payment of funeral services, to provide additional income to the individual's family in case of an accident, or to provide financial security to a loved one. A life insurance policy may cover a single insured or may cover two insureds where the death benefit is paid on death of the second insured (“survivorship insurance”). Corporations typically purchase or sponsor insurance products as a financing vehicle for benefit plans or to hedge against other liabilities. Consequently, there are a variety of different types of life insurance products available for purchase.
There are two basic types of life insurance, these two types are known as term insurance and permanent insurance.
Term life insurance provides a predetermined benefit payment for a specifically, designated period (e.g. for one, five, ten, or fifteen years). The insurer only pays the face value if the insured dies within the period in which the policy is in effect. If the insured lives longer than the term of the policy, the policy expires and the insurer pays nothing. Consequently, term life insurance does not build any cash value. As a result, this type of insurance is inefficient and does not offer a good return.
The principal advantage of term life insurance is that it is relatively inexpensive. However, because of its speculative nature, term life insurance is usually purchased as a means of temporary protection or when an individual cannot afford the cost of other forms of life insurance. There are renewable and non-renewable term life policies. A renewable term life insurance policy automatically re-qualifies the insured, who is able to continue the existing policy when the original term is up. In contrast, upon expiration of a nonrenewable policy, the insured must take another physical and answer more health questions in order to re-qualify for a new policy.
In an effort to improve the characteristics of term life insurance, insurers offer riders or benefits to improve the policy's characteristics. For example, many term life insurance policies are convertible, which allow the owner to exchange the term policy into a permanent form of life insurance. However, the costs associated with the conversion are typically high thereby lowering the return on this type of policy.
Permanent insurance provides lifetime coverage. Permanent insurance may be embodied in a variety of different forms, the forms may be whole life, universal life, and variable universal life. Whole life insurance provides lifetime protection as well as cash value. Typically, premiums remain at a fixed level throughout the insured's life or for a portion thereof (e.g. for 10 or 20 years). The cash value portion of a whole life insurance can build up on a tax deferred basis and the policy owner may access this cash value through loans or withdrawal. Accessing cash values is likely to reduce the policy's death benefit.
A whole life insurance policy may be surrendered for its cash value but may be subject to a surrender charge. Premiums paid into a whole life insurance policy are used to pay the cost of protection and a portion of the premiums is held in the insurance provider's general account where it earns interest.
Universal life insurance is another variation of permanent insurance. Universal life insurance, typically, provides more flexible benefits than whole life insurance. A policy owner can adjust the premium payments and/or death benefits of the policy to suit their needs. As with whole life insurance, a portion of premium is held in the insurance provider's general account where it earns interest. This allows the potential for cash value to accumulate. The cash value is accessible to the policy owner for loans and withdrawals.
Variable life insurance is the third form of permanent life insurance. As with other insurance policies, part of the premium payment goes toward the term life portion of the policy, part to administrative expenses, and part to the investment or cash value portion of the policy. The principal difference between variable life insurance and other types of insurance is that the owner is able to actively choose how to allocate the premiums in the investment portion of the policy. The owner typically may select from an array of investments options offered under the policy. As a result, there is a potential for a strong return. Typically, a policy owner may choose from a variety of investment options that each invest in a mutual fund. However, variable life insurance is generally more expensive than other forms of life insurance, and death benefits may fluctuate up or down depending on investment performance.
Variable life insurance policies address the perceived disadvantages of whole life insurance. Premiums are flexible and the internal rate of return may be higher because it moves with the financial markets. Whole life insurance is guaranteed to remain in force for as long as the required premiums are paid on a time. However, universal and variable life insurance, will typically lapse if there is not enough cash value to cover the policy's expenses.
Other types of insurance are well known in the art and have been designed to address other consumer needs. For example, long term care insurance provides a benefit payment to help pay for long term care costs as long as the covered individual meets certain prerequisites. In practice, these insurance policies can be structured similarly to life insurance. That is, the insured pays a predetermined premium for a specified amount of coverage. The difference between the forms of coverage lies in the different events that are covered by each type of insurance.
Generally speaking, the younger and healthier a person is, the cheaper it is to obtain life insurance, disability insurance, and the like. Conversely, it is more expensive for an older individual to purchase these types of policies. As a result, the various policies covering illness, serious accident, disability, and death have widely varying premium payments and payouts. Consequently, an individual who desires protection from one or more of these events must purchase an individual policy for each specific event. In short, if an individual wishes to mitigate the risks associated with a serious accident, illness, disability, or death, the individual must purchase separate policies.
Not only are typical policies such as long term care policies expensive, but there are several disadvantages associated with them. That is, in order to receive benefit payments, typically a covered individual must be physically confined to a long term care facility (e.g. a nursing home).